Understanding Unfunded Liability
Presented by Sue Feinberg & Marne Carlson
MERS Regional Managers
Today’s Objectives
• Defined benefit funding concepts
• What is unfunded liability?
• Strategies to reduce unfunded liability
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About MERS
• MERS is an independent, professional retirement services company that serves municipal members across the state of Michigan
• We are a nonprofit that is governed by an elected board that is committed to accountability and transparency
• These members include: – Three officers members
– Three employee members
– Two industry experts
– One retiree member
Pooling Powers Financial Security
• MERS administers more than 2,000 different plans • Each municipality’s retirement plan is maintained in
a separate trust, which gives our members the benefits of pooling resources for investments
• Pooling municipal assets for investment purposes provides huge benefits to members, including lower administrative costs
How is the Employer Contribution Calculated?
Actuarial Assumptions and Methods established by the Retirement Board
Funding Concepts • State statute requires that pension plans be pre-funded,
meaning regular contributions for each worker are made into the retirement fund during the course of that worker’s career − Set aside money now to pay for the benefit payments later − Investment income helps pay for the benefits
Basic Funding Equation
Contributions Investment
Income Benefit
Payments Expenses
Employer Contribution
Employer contribution rate is made of up two parts:
1. Employer Normal Cost– Present value of benefits allocated to the current plan year less any employee contribution
2. Amortization Payment of Unfunded Accrued Liability– Payment to reduce any shortfall between liability for past service and assets
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What is Unfunded Liability?
Unfunded liability is simply the difference between a pension plan’s estimated benefits and assets that have been set aside to pay for them
– The dollar value of the benefits is actuarially determined each year
– Assets are held in a trust and are professionally managed over the years
Why Do Unfunded Liabilities Occur?
• Benefit improvements • When municipalities don’t meet the minimal
required contributions as determined by the actuary
• Experience of the plan (investment experience and demographic experience) – This is the difference between what actually
happens in the plan compared to the actuarial assumptions
Distribution of Funded Percentage
Our Defined Benefit Plan is a multiple-employer plan • Assets are pooled for investment purposes only • Separate trusts are maintained for each individual employer • We do not borrow from one municipality’s account to cover
another municipality’s obligation
39 67
136
175
121
73 101
Under50%
50 - 59% 60 - 69% 70 - 79% 80 -89% 90 - 99% Over100%
2/3 Funded at
70% or higher
87% Average funded
percentage
Defined Benefit Case Studies
Und
erfu
nded
Pla
n • Joined MERS in 1992 • Transferred from an
external DC plan • Joined at 15% funded
• Added benefit improvements such as a cost-of-living adjustments
• Avg. pension $34,000 • 41% funded today
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Wel
l Fun
ded
Plan
• Joined MERS in 2004 • Transferred from an
external DC plan • Joined at 100%
funded • Made no benefit
improvement • Avg. pension $20,000 • 107% funded today
Strategies to Reduce Liability
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Cost-Reducing Strategies - MERS Strategy Description Trend
Impact
Cost Sharing for Existing Employees
Employees contribute to help fund the overall cost of the plan
• Reduces the employer cost, but does not affect total cost or the plan’s unfunded liability
Lower Benefit to New Hires
New hires receive a lower tier of Defined Benefit provisions
• Existing employees are not affected
• Reduces the liability for new hires
Bridged Benefits for Existing Employees
Benefits are offered in parts to existing employees Multiplier is then lowered on a going-forward basis
• Leaves earned benefits unchanged • Reduces the liability for new hires
and existing employees
Hybrid for New Hires
New hires receive a Hybrid Plan
• Existing employees are not affected
• Reduces liability for new hires
Defined Contribution for New Hires
New hires receive a defined Contribution Plan
• Existing employees are not affected
• Eliminates liability for new hires
Bonding Municipalities may bond for all or a portion of their unfunded accrued liabilities—pension or OPEB
• Proceeds of the bond are deposited and potentially will fully fund the unfunded accrued liability
• No guarantee that future unfunded liabilities may not occur
Voluntary Contributions
Additional payments made into plan toward unfunded liability
• Reduces existing liability • Extra dollars are invested and
recognize market returns
109 176 149
280 143
5 63 49 53 43
2 14 17 19 29
2010 2011 2012 2013 2014
6 31 67
31 37
11 21 20 45 30
4
180 211 200
Plan Design Strategies to Reduce Liability
Reduces the future liability accrual
Future benefits will be lower, and therefore less expensive, than the previous benefits offered
Lower Tiered Benefits for New Hires
• Lower multiplier • Removed cost of living
adjustments • Removed early retirement options • Increased vesting period • Increased retirement age
Action Impact
Lower Defined Benefit to New Hires
• New hires are covered by a lower tier of either Defined Benefit or Hybrid benefits
• Existing employees are not affected • Reduces the liability for new hires
Tier II
• 1.70% Benefit Multiplier • FAC 5 • Vesting of 10 years • No Early Retirement
provisions • No COLA
Anyone hired after 8/1/2014
Tier I • 2.5% Benefit Multiplier • FAC 3 • Vesting of 8 years • Early Retirement Age 55 with
15 years of service • COLA
Anyone hired before 8/1/2014
Plan Design Strategies to Reduce Liability
Eliminates future accrual of liabilities
New hires will not accrue liability
Defined Contribution Plan for New Hires
Action Impact
Changing Plans– Defined Benefit to Defined Contribution • New hires, rehires, and transfers are covered by
MERS Defined Contribution Plan − Active employees may be given a one-time option to convert
• Funding level for municipality and division is considered when making this change
• A projection study is required – Shows the long-term cost of the current benefit plan
compared to the long-term cost of the proposed benefit plan – Shows how employer contributions would be affected
20 years into the future
Plan Design Strategies to Reduce Liability
Action Impact Reduces future accrual of
liabilities
Future benefits will be lower, and potentially less expensive, than previous benefits
Hybrid Plan for New Hires
Defined Benefit to Hybrid
• New hires, rehires, and transfers are covered by MERS Hybrid Plan − Active employees may be given a one-time option to
convert if municipality meets funding requirements
• Actuarial report is needed to calculate the contributions for the Defined Benefit portion of the Hybrid Plan
Hybrid Plan Impact on Employees
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Eliminates future accrual of liabilities
Active employees accrue liability at a lower rate and may reduce existing liability. New hires receive the reduced multiplier
Plan Design Strategies to Reduce Liability
Bridged Benefit for Active Employees
Action Impact
Bridged Benefits
• Benefits are offered in parts to existing employees
• Multiplier is lowered on a going-forward basis
• Leaves earned benefits unchanged
• Reduces the liability for new hires and existing employees
Bridged Benefit Cost Impact
Benefit Multiplier
Division Funding Level Employer Contribution Rate
2.5%
75.3%
22.68%
Current Benefits
Proposed Benefits
2.0%
78.8%
17.68%
Difference
0.5%
3.5%
5.00%
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Impact on Employees Bridging Down – Decreasing Liability • John’s FAC for first 15 years of his career is $30,000 • For the next 10 years his FAC is $50,000 • His termination FAC is $50,000 • Without adopting Bridged Benefits, John’s Straight Life benefit
would have been $31,250 annually
Funding Strategies to Reduce Liability
Contributes to Unfunded Liability
The actuarial determined contribution is a formula based on Employer Normal Cost and Amortization Payment of Unfunded Accrued Liability
Contribute Annual Required Contribution (ARC)
Action Impact
Contributes to Unfunded Liability
Extra dollars are invested and have ability to recognize market returns
Contribute Above Annual Required Contribution (ARC)
• Extra percentage above minimum
• Lump sum payment
Conclusion
• Review municipality’s funding status through the Annual Actuarial Valuation
• Evaluate options for the future
• Continue to review best practices and implement fiscally responsible policies
Contacting MERS
MERS of Michigan 1134 Municipal Way Lansing, MI 48917 Phone: 800.767.6377 Fax: 517.703.9707 www.mersofmich.com
This presentation contains a summary description of MERS benefits, policies or procedures. MERS has made every effort to ensure that the information provided is accurate and up to date. Where the publication conflicts with the relevant Plan Document, the Plan Document controls.
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